FIA Analyzing Financing Activities

Topics: Balance sheet, Pension, Lease Pages: 23 (1346 words) Published: May 9, 2015
Overview of the Chapter










Current and Noncurrent Liabilities
Lease Obligations
Pension Liabilities
Contingent Liabilities & Commitments
Deferred credits or income
Off-Balance-Sheet Financing
Liabilities at the Edge of Equity
Equity Financing
Book Value per Share

Analysis of Liabilities
Areas of observations:






We need to make sure that companies account for all
of them with proper details as to their amounts, due
dates including conditions, encumbrances and
limitation
Most companies look for ways to reduce the amount
of liabilities reported in the financial statements
We must recognize that companies can misclassify or
inadequately describe liabilities

Where and How to Look?








Auditors are one source of assurance in our search
Auditors tools include; direct confirmation, review
board minutes, reading contract and agreement,
inquiry
In double entry system helps auditors and us
Most difficult item includes commitment and
contingent liabilities require no entry
To understand it, we need to management
discussion, reconciliation, notes

Example of motivated transactions
SEC determined Ampex Corporation failed to fully
disclose:
 Its obligation to pay royalty guarantees of 80 million
 A several million dollar understatement in the
allowance for doubtful accounts receivable
 Income overstatement from inadequate credit
allowances for returned tapes

Important Features in Analyzing Liabilities









Terms of indebtedness ( maturity, interest rate)
Restrictions on deployment of resources and freedom
in business activities
Ability and flexibility in pursuing further financing
Working capital, debt to equity
Dilutive conversion features that liabilities are subject
to
Prohibition on certain disbursements such as
dividends

Noncurrent Liabilities






Information on noncurrent liabilities should include
interest rate, maturity date, conversion privileges, call
features, subordination provision, and restrictions
Companies must disclose any defaults of debt
provisions, including defaults of interest and principal
repayments
Important items: purchase commitments which is
unconditional purchase obligations. Footnote
disclosure is required

Purchase Obligations







Description and term of obligation
Total fixed in determinable obligation
Description of any variable obligation
Amounts purchased under obligation
For purchase obligations that are recognized on
purchaser’s balance sheet, a company must report
payment fro each of the next five years

Leases








A lease is a contractual agreement between lessor
(owner) and a lessee (user)
It gives a lessee the right to use an asset, owned by
the lessor, for the term of the lease
In return, the lessee makes rental payments, called
minimum lease payments (or MLP)
Lease terms obligate the lessee to make series of
payments over a specified future time period

Types of Leases









A lease that transfers substantially all the benefits and
risks of ownership is accounted for as an asset
acquisition and liability to be paid off
similarly the lessor treats such lease as a sale and
financing transaction
This type of lease is called a capital lease
If classified as capital lease, both the leased asset and
the lease obligation are recognized in the balance sheet
All other leases are operating lease

Types of Leases








Lesses often structure a lease so that it can be
accounted for as an operating lease even when the
economic characteristics of the lease are more in line
with a capital lease
By doing so, the lessee may convert the transaction
in off-balance sheet financing
Off balance sheet financing refers to the fact that
neither the leased asset nor its corresponding liability
are recorded in the balance sheet
Analyst must be careful in...
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